Substantial Control Under the CTA

In its proposed CTA regulations, FinCEN defines "substantial control" in a way that will increase corporate governance and filing obligations for millions of U.S. companies.

Corporate Transparency Act Regulations

The Corporate Transparency Act (or "CTA") was adopted by Congress in December 2020. This new law, when implemented by FinCEN, will require most U.S. companies to file reports that disclose the company's beneficial ownership. FinCEN issued proposed regulations in December 2021. FinCEN's proposed regulations define "beneficial owner" to include two categories. First, a beneficial owner is any person who owns more than 25% of the Company. Second, a beneficial owner is also any person who has "substantial control" over the company. FinCEN's proposed definition is a complicated thicket of overlapping concepts.Applying this definition will pose challenging for many U.S. companies.

Definition of "Substantial Control"

FinCEN defines "substantial control" as:
  • Service as a senior officer of the reporting company;
  • Authority over the appointment or removal of any senior officer or a majority or dominant minority of the board of directors (or similar body);
  • Direction, determination, or decision of, or substantial influence over, important matters affecting the reporting company, including but not limited to:
    • The nature, scope, and attributes of the business of the reporting company, including the sale, lease, mortgage, or other transfer of any principal assets of the reporting company;
    • 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 of the reporting company;
    • The selection or termination of business lines or ventures, or geographic focus, of the reporting company;
    • Compensation schemes and incentive programs for senior officers;
    • The entry into or termination, or the fulfillment or non-fulfillment of significant contracts; and Amendments of any substantial governance documents of the reporting company, including the articles of incorporation or similar formation documents, bylaws, and significant policies or procedures; and
  • Any other form of substantial control over the reporting company.
As a result, many companies will find this multi-part definition challenging to apply.

Applying the Definition of "Substantial Control"

For example, the proposed regulation defines "service as a senior officer" as "substantial control." Presumably then, each reporting company should list its chief executive officer as one of its beneficial owners. But should a reporting company list its other officers as well? Would the reporting company's chief financial officer be a "senior officer." In many companies it would. However, the second prong of the definition provides that "authority over the appointment or removal of a senior officer" indicates "substantial control." If the CFO lacks the authority to hire and fire other senior officers, does that mean that the CFO lacks substantial control? Most corporate boards have the power to appoint the corporation's senior officers. But does this mean that each member of the board is a beneficial owner? The proposed FinCEN regulation does not require a corporation to list every board member in its beneficial ownership report. Elsewhere in its proposed regulations, however, FinCEN states that, "An individual may directly or indirectly exercise substantial control over a reporting company through a variety of means, including through board representation . . . " This suggests that some board members may have substantial control while others may not. FinCEN does not distinguish, however, between those board members who have substantial control versus those who do not. Companies who must file beneficial ownership reports under the CTA will find this definition of substantial ownership difficult to apply. The CTA provides that it is a felony for any individual willfully to file an inaccurate report. (CTA, Sec. 6403(h)). Those responsible will not want to put themselves in legal jeopardy for making a judgment call about which directors have substantial control.

Corporate Governance Policy to Implement Regulations

As a result, many companies will likely choose to be overly broad. They will include in their list of beneficial owners any officer or director who might possibly have substantial control. As a consequence, they will increase the number of individuals whose identifiable information must be included in the company's beneficial ownership report. In Part 2, I will describe some practical steps companies can take to comply with their CTA obligations.

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