In early December, the Financial Crimes Enforcement Network (“FinCEN”) released a much- anticipated proposed rule requiring certain types of legal entities to submit, among other things, beneficial ownership information to a centralized registry. The proposed rule defines the types of companies that are subject to reporting, further defines “beneficial ownership” and the types of reporting information that should be reported, and outlines the penalties associated with non-compliance.  

Proposed Rule vs. Existing Customer Due Diligence Rule (the “CDD Rule”) – an Expansion in Coverage

The proposed rule is different from the CDD Rule, which went into effect in the Spring of 2018, by expanding the definition of “beneficial owner” to include any person who: (i) exercises substantial control over a reporting company; or (ii) owns or controls at least 25% of the ownership interests of a reporting company; whereas the CDD Rule defines beneficial ownership as (i) each individual who owns 25% or more of the equity interests of a legal entity customer; and (ii) a single individual with significant responsibility to control, manage, or direct a legal entity customer.  

In other words, the proposed rule does not limit the significant control prong mentioned above to a single person; and does not follow the CDD Rule’s limitation of those deemed to have “significant responsibility” to senior managers, executive officers or people who routinely perform similar functions. Rather, the proposed rule significantly increases the types of authority that could trigger an individual’s designation as a beneficial owner.  

Finally, FinCEN clarified that an ownership interest is not simply limited to equity in the reporting company (as with the CDD Rule) and could include partnership interests, convertible instruments, or any other similar right to acquire an interest in a reporting company. Once FinCEN reviews all public comments, a final rule will be issued and an effective date for the reporting requirements will be established. Important elements of the reporting framework are currently being developed, such as the format and mechanism for filing the required information.

Required Reporting Information

Eligible companies are required to file an initial report with FinCEN containing the company name, trade names, state of formation, address, and Tax-Payer Identification Number; and for each beneficial owner, the report must specify the beneficial owner’s full legal name, address, “unique identifies (e.g., number from driver license, passport or other government ID). Any changes to the data from the initial report must be updated with FinCEN within 30 days.

Reporting Companies and Exceptions

The significant legal entity exceptions to the proposed rule (meaning, they do not have to file eligible reports) for most readers of this blog are:  banks, credit union investment companies and broker-dealers, pooled investment vehicles, Exchange-Act-Registered entities (e.g., publicly-traded entities subject to periodic regulatory reporting) and “large operating companies” (i.e., companies that have more than 20 full-time US employees, a physical address in the US, have previously filed a tax return in the last year with more than $5M in gross sales). Companies which do not meet the exception will include: (i) both domestic companies established and registered in the US and foreign entities established in foreign jurisdictions; and (ii) registered to conduct business in the US. Examples of such entities include trusts, LLCs, and corporations.

So What?

The proposed rule represents an important step in addressing known gaps in the financial crimes prevention framework in the U.S., namely the lack of accurate beneficial ownership information at the federal level and the historical use of shell companies and other similar vehicle to launder money, avoid taxes and finance terrorism. 

This is the first of three (3) rules required to be proposed by FinCEN – the others will create a beneficial ownership registry and amend the CDD Rule to be more in-line with other regulatory requirements. Affected institutions should monitor these developments closely as it may require changes to the types of data captured (including outreach and remediation) and developing governance processes around existing financial crimes compliance processes to account for reporting and ongoing monitoring. Other potential effects could include: coordinating with third-party vendors to ensure appropriate information is captured; updating existing policies and procedures relating to CDD/EDD, CIP and SAR reporting; updating training modules.

Contributors:

Spencer Schulten, US Head of Financial Crimes Compliance 
Ed Kelley, Managing Principal
Hardik Desai, Principal Consultant
Trisha Stone, Principal Consultant