BizTech Law Blog

I. General Rule

The CTA requires “reporting companies” to provide information about their “beneficial owners” to a federal database managed by the U.S. Financial Crimes Enforcement Network (“FinCEN”).

The new requirement was implemented as part of the National Defense Authorization Act for Fiscal Year 2021 and is intended to assist law enforcement with combatting money laundering, terrorist financing, corruption, and tax fraud, among other criminal activity.

The CTA’s scope includes both domestic and foreign companies organized as corporations, limited liability companies, and other entities formed by filing a document with the secretary of state or any similar office under the law of a state or Indian tribe.

II. Entities Excluded from CTA

There are 23 exceptions to definition of “reporting company.” In general, companies within highly regulated industries are exempt. For example, banks, governmental entities, credit unions, nonprofit entities, and securities brokers are specifically excluded from the CTA. Of note, “large operating companies” are also exempt. A Large Operating Company is an entity that (a) employ 20 or more full time employees in the U.S., (b) filed a federal income tax return for the previous year reporting $5,000,000 or more reporting in gross receipts or sales, and (c) has an operating presence in the U.S.

III. Beneficial Owner

As noted above, every reporting company must provide information about its beneficial owners to FinCEN. A “beneficial owner” is an individual who either directly or indirectly (a) exercises substantial control over the reporting company or (b) owns or controls at least 25% of the reporting company.

a. Substantial Control

The analysis as to who is a beneficial owner is based on substantial control and requires a facts and circumstances analysis. Notably, the CTA regulations consider beneficial owners to include senior officers, individuals with the authority to appoint or remove certain officers or directors, and individuals that make important decisions on behalf of the business. Important decision makers are those individuals who control (1) the nature, scope, and attributes of the business, (2) major expenditures or investments on behalf of the business, or (3) decisions regarding reorganization or dissolution, for example.

b. 25% or More Ownership Interest

An individual will also be a beneficial owner if he or she holds 25% or more ownership interest in the business. For corporations, this means anyone who directly or indirectly owns 25% or more of the outstanding stock. For a limited liability company, it means the individual who owns 25% or more of the membership interest or profits interest.

IV. Applicability to ESOPs

Each ESOP-owned company will be a reporting company unless it is covered by an exception. The exception that will most often be implicated for ESOP-owned companies is the large operating entity exception. If an ESOP-owned company meets the requirements of (a) having 20 or more full time employees in the US, (b) having filed a federal income tax return for the previous year with $5,000,000 or more reporting in gross receipts or sales, and (c) having an operating presence in the US, then no report must be made to FinCEN about the ESOP-owned company.

If, however, the ESOP-owned company is required to report, then an analysis as to who the beneficial owners are must be completed.

Although FinCEN has issued rules, FAQs, and compliance guides, FinCEN has failed to provide guidance about ESOPs and how the analysis of “beneficial owner” may impact ESOP participants. Without specific ESOP guidance, ESOP companies will be required to analyze and determine their beneficial owners based on the non-ESOP specific guidance that has been published. In fact, the analysis for ESOPs remains the same as with any company that it is determining its obligation to report. We outline some considerations for ESOP-owned companies below.

a. Trustee Reporting

One ESOP-specific issue that has been discussed in the ESOP community is whether an ESOP trustee will be required to report as a beneficial owner. It is arguable that the ESOP trustee (whether internal or external) has substantial control over the reporting company – especially if the ESOP owns 100% of the entity and the trustee is therefore permitted to vote on the board or remove board members.

FinCEN does exempt some individuals from reporting. Such exceptions are limited to instances where the individual’s substantial control over the business is derived solely from the employment status of the individual with the reporting company. Although this exception appears helpful, it would not apply to either internal or external trustees. While internal trustees are company employees and as employees, they may be exempt from reporting, their role as a trustee may make them a beneficial owner.

The determination about whether an internal trustee is required to report will be determined based on the authority of the trustee. For example, the CTA rules specifically state that individuals who have authority to appoint or remove any senior officer or a majority of the board will be considered to have substantial control over the business and will therefore be a beneficial owner. Given this rule, internal trustees could be required to report as beneficial owners. Similarly, external trustees (who are not employees of the company) may be required to report under the “substantial control” analysis if they have substantial control over the business as noted above.  This rule must be applied on a case-by-case basis to make an accurate determination.

Additionally, FinCEN appears to be taking the stance that trustees control the trust assets. This implies that the trustee does not own the assets and that an ownership analysis must be completed for the assets of the trust. The CTA final regs provide a list of individuals who are beneficial owners when a trust owns or controls at least 25% of the ownership interest in the reporting company.

b. ESOP Participant Reporting

Merely being a participant in the ESOP does not automatically make a participant also a beneficial owner for purposes of the CTA. There appears to be a few ways, however, that a participant may be required to report as a beneficial owner. This is helpful because it would be difficult to report every individual who owns a portion of stock through an ESOP.

First, if the participant meets either of the beneficial owner tests (substantial control or 25% owner), he or she will be required to report.

Additionally, if the ESOP Trust owns 25% or more in the reporting company, then the individuals who own the interest in the reporting company through the trust may qualify as beneficial owners. There are exceptions and specific rules to how this component may be applied to ESOP trusts and this remains a grey area in the regulations.

Companies that are owned by ESOPs must consider how the ESOP impacts its CTA reporting requirements. This is a fact intensive analysis and must be completed with diligence. One of Foster Swift’s ESOP Attorneys can assist you, and you may refer to our CTA Information page here: https://www.fosterswift.com/f-corporate-transparency-act-resources.html

ESOP Attorneys at Foster Swift:

• Mindi M. Johnson...P: 616.726.2252...E: mjohnson@fosterswift.com 
• Amanda J. Dernovshek...P: 517.371.8259...E: adernovshek@fosterswift.com