Private Equity and Corporate Transparency Act

U.S. private equity and venture capital investments in U.S. based companies below Hart Scott Rodino thresholds typically do not require any governmental filings and the amount of investment and information about the fund and its individual owners is typically not required to be filed.  Moreover, information on the control structure and individual ownership of these funds also is generally not required to be filed by the fund’s portfolio companies.  

This is the case no longer.  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) will now require private equity and venture capital firms to consider whether they or their portfolio companies are required to file reports with FinCen under the CTA.   The CTA was the culmination of a multi-year effort by Congress, the Department of Treasury (Treasury), other national security agencies, law enforcement, and other stakeholders to bolster the US corporate transparency framework.  These stakeholders believe that the current lack of a corporate transparency framework allows illegal activity to be hidden behind corporate and other entities.  While investment by funds is not the real target of CTA, funds may nonetheless be swept up if they form investment vehicles which are not exempt and/or make investments in companies not exempt from filing information reports with FinCen.  In addition, this information will be accessible to other governmental agencies to conduct investigations beyond money laundering investigations. 

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

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What companies will need to file FinCen reports?

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 these criteria in any given year, will be required to file.

Further, there are also exemptions for some typical investment companies and funds (such as broker/dealers, investment companies and investment advisors registered with the SEC, and pooled investment vehicles advised by an investment advisor registered with the SEC), However, a fund may itself not qualify for an exemption and it may be required to file a report with FinCen under the CTA.  However, even if the fund itself is exempt, the exemption may not apply to the portfolio companies that such investment funds hold investments in.  In certain instances, controlled or wholly-owned subsidiaries of exempt entities may also be exempt from reporting – although under the proposed FinCen rules – portfolio companies wholly-owned or controlled by pooled investment vehicles would not be exempt.    

What would be required to be filed?

The CTA and the proposed FinCen regulations require covered entities to report their senior officers, investors (or individuals 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 an investor with substantial control may require the listing of investors (or individuals controlling investors) which have considerably less than 25% ownership.  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 such control and require that party to be reported.  Ownership (and perhaps control) held through multiple entities will be followed through the chain and aggregated to determine the amount of ownership (and control) in the portfolio company 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 have substantial influence over the exercise of control by the fund may need to be listed as well  if the fund holds a reportable beneficial interest in the portfolio company.

When would filing be required under the Corporate Transparency Act

Under the proposed FinCen rules, covered entities which are created after the FinCen rules are final will have 14 days to file the required information with FinCen.  Under the proposed FinCen rules, all covered entities in existence prior to the FinCen rules becoming final would have 12 months to file their initial report.  However, these time periods may change when the proposed FinCen Rules are made final.

 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 a covered entity 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. 

Private equity and venture capital firms will want to expand their due diligence to ensure that any company in which they contemplate investment wither has made the required filings or is exempt, and makes any appropriate updates after the investment.  

Private equity and venture capital firms will also need to determine whether they qualify for an exemption themselves or whether they need to file a report with FinCen as well.  Private equity and venture firms 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. Private equity and venture capital firms may also consider whether to seek a FinCen identifier for persons associated with the fund (e.g. control persons) to simplify the information that a portfolio company may be required to file.  Absent getting their own FinCen identifier, private equity and venture capital firms 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 Corporate Transparency Act and Private Equity

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