The 2021 National Defense Authorization Act (the NDAA) was enacted on January 1, 2021. Part of it imposes new beneficial ownership reporting requirements on some businesses formed or registered to do business in the US. Owners of some businesses with less than $5 million in sales or less than 20 full time employees or without a physical operating presence in the U.S. will now need to file personal identifying information with the U.S. Financial Crimes Enforcement Network (FinCEN).
While many of the details are not yet known, the Act brings the US closer to global standards on anti-money laundering (AML) regulations. It also may significantly affect the way US businesses approach formation matters and early-stage financing.
The Act requires certain reporting companies to submit a report identifying each beneficial owner and applicant, and providing identifying information.
Required Contents of Report to FinCEN
In the mandated report to FinCEN, a reporting company must identify each of its beneficial owners and applicants by providing:
Full legal name;
Date of birth;
Current residential or business street address; and
Unique identifying number from (i) a non-expired U.S. passport; (ii) a non-expired state or federal identification document, (iii) a non-expired state-issued driver’s license, or (iv) if a beneficial owner does not have any of the aforementioned documents, a non- expired foreign passport.
The reporting obligations take effect when the Treasury Secretary issues regulations but no later than one year from January 1, 2021.
Reporting companies formed in the US or registered to do business in the US after the Effective Date will (in addition to applicable state filing requirements) need to submit to FinCEN a report with the required information at the time of formation or registration (as applicable).
Reporting companies that are (i) formed in the US prior to the Effective Date or (ii) registered to do business in the US prior to the Effective Date must submit a report containing the required information within two years of the Effective Date. In the event of a change to any of the information required to be included in the report, a reporting company will need to submit an updated report to FinCEN within one year from the change. The Treasury Secretary has the authority to increase the frequency of the requirement pending the outcome of a cost-benefit analysis.
What is a Reporting Company?
The core definition of reporting company picks up many small business owners but it is also subject to many exceptions that narrow its scope.
A reporting company is any corporation, limited liability company (LLC) or similar entity that is either (i) created by filing a document with the secretary of state or similar office of any state or Indian Tribe; or (ii) formed under the law of a foreign country but registered to do business in the US by filing a document with any secretary of state or similar office of any state or Indian Tribe.
What an entity “similar to” a corporation or LLC is yet to be determined.
The broad definition of reporting company is restricted by a list of more than 20 classes of excluded entities. They include:
An entity that (i) filed a tax return showing more than $5,000,000 in gross receipts or sales in the prior year, and (ii) has 20 or more full-time employees, and (iii) has a physical operating presence in the US. Many small businesses do not meet all three of these criteria and will be subject to the law.
An SEC reporting company;
A bank, bank holding company, credit union, registered investment company, investment adviser, or insurance company along with certain other entities engaged in financial services or otherwise highly-regulated entities;
An entity that satisfies all of the following: (i) in existence for over one year; (ii) not engaged in active business; (iii) not owned, directly or indirectly, by a foreign person; (iv) in the preceding 12-month period, did not experience a change in ownership or send or receive funds in an amount greater than $1,000 (including all funds sent to or received from any source through a financial account or accounts in which the entity, or an affiliate of the entity, maintains an interest); and (v) does not otherwise hold any kind or type of assets, including an ownership interest in any corporation, LLC, or other similar entity;
An entity in which the ownership interests are owned or controlled, directly or indirectly, by certain other types of exempt entities; and
Such other classes of entities as the Treasury Secretary, with the written concurrence of the Attorney General and the Secretary of Homeland Security, may, by regulation determine should be exempt from the requirement.
The Act is drafted to exclude those companies with greater indicia of legitimacy or that are already highly regulated. It focuses on entities that pose the greatest perceived AML risk. This means the beneficial ownership reporting requirements will likely most significantly affect startup companies and other small businesses.
Some exempt entities may still be required to submit a report to FinCEN, although the information required to be included is more limited. It is likely exempt entities will be required to make an election to be exempt from the reporting requirements. The regulations will likely require them to apply for an exemption with FinCEN.
Definitions of Beneficial Owner and Applicant
An “applicant” is any person who files the documentation to form a reporting company or registers a reporting company to do business.
A “beneficial owner” is an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise (i) exercises substantial control over the entity; or (ii) owns or controls not less than 25 percent of the ownership interests of the entity.
The following are expressly excluded from the definition of “beneficial owner:”
A minor child if the information of the parent or guardian of the minor is reported;
An individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual;
An individual acting solely as an employee of an entity and whose control over or economic benefits with respect to the reporting company is only from employment status;
An individual whose only interest in the reporting company is through a right of inheritance; or
A creditor of the reporting company unless the creditor otherwise qualifies as a beneficial owner.
A beneficial owner is determined by an economic interest or control test, although the interpretation and application of both is unclear.
Substantial control is not defined. Indicators of control could include possession of special voting rights, appointment or veto powers, and or approval of operational or strategic decision-making.
A reporting company will need to evaluate potential beneficial owners in light of both the 25 percent ownership and substantial control tests in the Act. It is likely that guidance will be included in the regulations to be issued.
Additionally, if an entity is excluded from being a reporting company because it is a subsidiary of one or more exempt entities, it will be necessary only to list the name of that exempt entity in its FinCEN report.
Penalties & Safe Harbor
The Act has penalties applicable to reporting violations and unauthorized uses or disclosures of beneficial ownership information.
It is unlawful for any person to;
Willfully provide, or attempt to provide, false or fraudulent beneficial ownership information, including a false or fraudulent identifying photograph or document, to FinCEN; or
Willfully fail to report complete or updated beneficial ownership information to FinCEN.
Liability includes (a) a civil penalty of not more than US$500 for each day that the violation continues or has not been remedied; and (b) a fine of not more than US$10,000, imprisonment for not more than two years, or both.
There is a safe harbor against civil or criminal penalties for some reporting violations to the extent a person (i) has reason to believe that any report submitted by such person in accordance with the Act contains inaccurate information; and (ii) under the regulations, voluntarily and promptly, and in no case later than 90 days after the date on which the person submitted the report, submits a report containing corrected information.
The safe harbor does not apply if the person acted for the purpose of evading the reporting requirements or had actual knowledge that information contained in the report was inaccurate.
It is also unlawful for any person to knowingly disclose or knowingly use the beneficial ownership information obtained by such person through a report submitted to FinCEN or a disclosure made by FinCEN. Penalties for unauthorized disclosure or use are
A civil penalty of not more than US$500 for each day that the violation continues or has not been remedied; and
A fine of not more than US$250,000, imprisonment for not more than five years or both; or if the violation occurred in connection with violation of another U.S. law or as part of a pattern of any illegal activity involving more than $100,000 in a 12-month period, a fine of not more than $500,000, imprisonment for not more than 10 years, or both.
Retention of Information Provided to FinCEN; Procedure for Access
The information reported to FinCEN will not be publicly available. It can be shared with federal law enforcement agencies. State, local, and tribal law enforcement agencies may het FinCEN registry information with court approval. FinCEN may disclose information only upon receipt of:
A request, through appropriate protocols from (i) a federal agency engaged in national security, intelligence, or law enforcement activity, for use in furtherance of such activity; or (ii) from a state, local, or tribal law enforcement agency, if a court of competent jurisdiction, including any officer of such a court, has authorized the law enforcement agency to seek the information in a criminal or civil investigation;
A request from a federal agency on behalf of a law enforcement agency, prosecutor, or judge of another country, including a foreign central authority or competent authority under an international treaty, agreement, convention, or official request made by law enforcement, judicial, or prosecutorial authorities in trusted foreign countries when no treaty, agreement, or convention is available that is (i) issued in response to a request for assistance in an investigation or prosecution by the foreign country; and (ii) that (a) requires compliance with the disclosure and use provisions of the treaty, agreement, or convention, publicly disclosing any beneficial ownership information received; or (b) limits the use of the information for any purpose other than the authorized investigation or national security or intelligence activity;
A request made by a financial institution subject to customer due diligence requirements, with the consent of the reporting company, to facilitate the compliance of the financial institution with customer due diligence requirements under applicable law; or
A request made by a federal functional regulator or other appropriate regulatory agency.
Beneficial ownership information for each reporting company must be maintained by FinCEN for not fewer than five years after the date on which the reporting company terminates.
This is a significant change from previous reporting obligations in the US and imposes substantial new federal reporting requirements in connection with small businesses, new business formations, and registration of a foreign business in the US.
Prior to now, there has been no federal requirement to provide any information on individuals forming, owning, and exercising control over small or new US businesses.
States vary on the information required to be provided in connection with formation and foreign registration filings made in a state. Many states currently require little or no identifying beneficial owner information.
With the advent of the new reporting requirements, however, sensitive personal information will be required to be given to an agency of the US government for existing small businesses and on formation or registration of new entities.
The Act will not become effective until the Treasury Secretary enacts regulations and the regulations should help clarify the Act. It is not too early to begin considering measures to adjust to the Act.
Potential amendments to current documents may include (i) limitations upon or carve-outs to confidentiality clauses in operating agreements or other organizational or governing documents to permit compliance with the Act; and (ii) an express obligation upon, as applicable, stockholders, directors, members, managers and other interest holders and controllers to provide information necessary for a reporting company to submit and update beneficial ownership information, including significant penalties as and to the extent permitted by law for failure to comply with such obligation.