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By Sabrina D. Johnson
March 18, 2024
As explained in more depth in our previous article, FinCEN Corporate Transparency Act Update, every corporation, limited liability company, or other entity formed by filing with the secretary of state (such as, in California, a limited partnership) is a “Reporting Company.” Each Reporting Company is required to file with FinCEN an initial report of its “Beneficial Owners”—both those individuals who hold 25% or more of the Reporting Company’s ownership interests, and those individuals who exercise “substantial control” over the Reporting Company.
In our previous installment of our Corporate Transparency Act (“CTA”) series, we discussed the “ownership” prong of the CTA reporting requirements. As detailed in the article, anyone with 25% or more ownership interest in a reporting company qualifies as a “Beneficial Owner” under the CTA, and must report their information to FinCEN. However, the analysis does not stop there—in addition to individuals with qualifying ownership percentages, there is a second “prong” of beneficial ownership: any individual who exercises “substantial control” over the reporting company.
Unlike the ownership prong, which necessarily is capped at four individuals, the “substantial control” prong requires that the entity report any individual who meets the definition—there is no limit on the number of individuals who must be reported. To this end, if there are ten separate individuals who meet the requirements for exercising “substantial control,” all ten are considered Beneficial Owners and must submit their information in the report.
Per the CTA, any individual with “substantial control” over a reporting company is considered a Beneficial Owner. The CTA specifically defines “substantial control” to include the following:
- Any individual who serves as a “senior officer” of the reporting company.
- According to FinCEN, this includes anyone holding the position or exercising the authority of a President, Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Operating Officer (COO), General Counsel, or any other officer performing a similar function.
- Any individual with authority over the appointment or removal of any senior officer, or a majority of the board of directors (or similar body).
- Any individual that “directs, determines, or has substantial influence over important decisions made by the reporting company.” The CTA provides specific examples of important decisions:
- The nature, scope, and attributes of the business, including the sale, lease, mortgage, or other transfer of any principal assets;
- The reorganization, dissolution, or merger of the reporting company;
- Major expenditures or investments, issuances of any equity, incurrence of any significant debt, or approval of the operating budget;
- The selection or termination of business lines or ventures, or geographic focus;
- Compensation schemes and incentive programs for senior officers;
- The entry into or termination, or the fulfillment or non-fulfillment, of significant contracts;
- Amendments of any substantial governance documents (including the articles of incorporation or similar formation documents, bylaws, and significant policies or procedures).
- Any individual who has “any other form of substantial control over the reporting company.”
In short, the definition of “substantial control” is an intentionally broad one, including a vague catch-all at the end for individuals with “any other form of substantial control” over the company. The CTA is written this way to close any potential loopholes. The message is clear: when in doubt, err on the side of reporting.
Additionally, “substantial control” includes both direct and indirect exercise of control. The CTA provides additional examples through which an individual could exercise indirect control of a reporting company:
- Board representation.
- Ownership or control of a majority of the reporting company’s voting power or voting rights.
- Rights associated with a financing arrangement or interest in the reporting company.
- Control over one or more intermediary entities that separately or collectively exercise substantial control over the reporting company.
- Arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees.
- Any other “contract, arrangement, understanding, relationship, or otherwise.”
Again, the breadth of examples emphasizes the sweeping intent of the CTA. Individuals may not hide behind votes, financing structures, or tiers of entities—if an individual exercises “substantial control” through any of these indirect mechanisms, the individual must report their information to FinCEN.
From a practical standpoint, reporting companies should take a careful look at the individuals with influence or control over the company, to capture all individuals who meet the definition of “substantial control.” Under the catch-all provisions, voting rights on certain types or categories of decisions might mean that otherwise passive investors in a reporting company may have “substantial control” for purposes of CTA reporting. Additionally, business owners subject to the CTA should consider amending corporate governance documents to make it an express requirement that beneficial owners comply with the CTA. This will make compliance with such a broadly sweeping requirement much easier to enforce.
For assistance with the CTA reporting, including amending governance documents to address the new requirements, or with any other questions, please contact Sabrina Johnson at sjohnson@hechtsolberg.com or Mickey Maher at mmaher@hechtsolberg.com.