Family Offices and Corporate Transparency Act

Family offices have had considerable leeway in setting up investment vehicles and making investments in early stage start-ups.  Those investment vehicles and investments are typically not subject to any governmental filing or information requirements by the family office or the company.  Also, information on who controls a family investment which may be through trusts or otherwise are generally not required to be filed.  However, with the enactment of the Corporate Transparency Act (CTA) and the proposed rules by the U.S. Department of Treasury’s federal Financial Crimes Enforcement Network (FinCen) family offices in certain instances may now need to file certain information on the ultimate individual owners and controlling individuals of investment vehicles with FinCen and to provide this information to portfolio companies as part of their investment.     

In addition to family offices, the Corporate Transparency Act and compliance raises issues for start-ups, private equity, small businesses, and international businesses.

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What companies will need to file CTA-compliant reports?

The CTA and the proposed FinCen regulations will require any entity which is formed through the filing with a secretary of state or similar tribal authority to file a report with FinCen listing senior officers, and beneficial owners of 25% or greater of the entity and persons with substantial control over the entity.  In addition, the CTA and proposed FinCen regulations will require many early stage companies that receive outside investment to file a report with FinCen listing investors with 25% or greater holdings and investors with substantial control (which under the proposed FinCen rules would include many investor common control features (such as board representation)) and to keep these reports current as information changes.  These information requirements are for the individuals who own 25% or more or control the investor if the investment is made through a separate investment entity.  

While the CTA applies to all U.S. entities which are formed through a filing with a secretary of state or similar tribal authority, and foreign entities which have registered to do business in the U.S. with a similar filing, there are exceptions.  Generally, the CTA and the proposed FinCen regulations will not require companies that have more than $5 million in U.S. gross revenue in the prior year, 20 or more full-time employees and a physical separate U.S. office to be exempt from the filing requirements. However, start-ups and firms that do not meet all three criteria, or fall below it in any given year, will be required to file.  While an exemption might apply for certain family investment vehicles (such as investment companies and investment advisors registered with the SEC, and pooled investment vehicles operated or advised by an investment advisor), the exemption would not apply to the portfolio companies that such investment funds hold investments in.  While there are certain exemptions for wholly-owned or controlled subsidiaries of exempt companies, under the proposed FincCen rule, these do not extend to pooled investment vehicles.  Further, investment vehicles which are not exempt will also have to file a report on individual beneficial owners.  It is not clear  that an entity formed to hold an investment in a covered entity will have any of the revenue or persons attributed to it – so it is likely that the investment entity may need to file as well if it has no revenue or employees of its own.  

What would be required to be filed under FinCen?

The CTA and the proposed FinCen regulations require covered entities to report their senior officers, investors (or persons controlling investors) with 25% or greater holdings, individuals with substantial control (which under the proposed FinCen rules would include many investor common control features (such as board representation, limitations on changes to the business, etc.)) to FinCen along with listing certain information on these parties.  The information required on  individual beneficial owners, include name and address, number associated with a form of government issued identity document (such as passport or drivers license), and a photo of the document.  

What constitutes a person with substantial control may require the listing of investors (or individuals controlling investors) which have considerably less than 25% ownership and might not otherwise be thought of having control. For example, the proposed FinCen rules state that the following, among other things, may constitute substantial control: 

• Being a Board member or manager of a limited liability company;

• Ownership of a majority or dominant minority of the voting shares of the company;

• Rights associated with any financing arrangement or interest in the company; and

• Through arrangements of financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees or through any contract, arrangement, understanding, relationship, or otherwise.

Moreover, any right to exercise control, even if not exercised, is nonetheless considered to be the exercise of such control and require that party to be reported.  Ownership held through multiple entities will be followed through the chain and aggregated to determine the amount of ownership and whether an individual may be required to be listed.  While not entirely clear from the proposed FinCen rules, it would appear that individuals which control a fund or trust, or have substantial influence over the exercise of control by the fund or trust, may need to be listed as well.  While this information will not be publicly available, it will be available to other governmental agencies and could be disclosed if FinCen is subject to a cyber attack.  

What happens if you fail to file?

Failure to file these reports will result in significant fines and potential jail time.  The proposed FinCen rules also will require covered entities to monitor its beneficial owners and file information when it changes – which will require covered entities to establish systems to track their beneficial owners.  Also, portfolio companies will need to add compliance with the proposed reporting requirements to any fund raise as investors may seek rights which may trigger the need for filing of an updated report and listing them as a beneficial owner.   

What should family offices firms do now to comply with Corporate Transparency Act?

Family offices will want to examine their current corporate and limited liability entities to determine if they must file the necessary information regarding their beneficial owners with FinCen.  In addition, family offices will need to build into their process for the formation of any new entity the requirement to determine if it is exempt from filing or to make the requisite filing with FinCen.  Family offices also will want to expand their due diligence to ensure that any company in which they contemplate investment which is required to make filings has already made the requisite filings and makes any appropriate updates after the investment or whether it is exempt from filing.  A family office will need to gather and be prepared to provide any information that may be required for controlling persons of the fund if the portfolio company is required to make filings.  Family offices will also need to ensure that they notify portfolio companies when any reported information changes as the reporting company has a relatively short window to file updated reports.  

Final Thoughts on Family Offices and Corporate Transparency Act

The proposed FinCen rules are not yet final and may change.  Klemchuk is closely following the FinCen rules as they get finalized and stand ready to assist clients in assessing whether they have to file the beneficial owner reports and to assist in such filings.

If you have any questions, please contact Mark Stachiw or Gabriela Smith.

For more information on corporate law, see our Corporate and Commercial Legal Services and Industry Focused Legal Solutions pages.

This post has been provided for informational purposes only and is not intended and should not be construed to constitute legal advice. Please consult your attorneys in connection with any fact-specific situation under federal law and the applicable state or local laws that may impose additional obligations on you and your company. © 2022 Klemchuk LLP