Substantial Control Under the CTA

In its Final Rule, 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 final regulations to implement the law in September 2022 that define "beneficial owner" to include two categories.

Ownership of 25% or More of Ownership Interests

First, a beneficial owner is any person who "owns or controls at least 25 percent of the ownership interests of" the reporting company.

The regulations define "ownership interests" as follows:

(i) Definition of ownership interest. The term "ownership interest" means:
(A) Any equity, stock, or similar instrument; preorganization certificate or subscription; or transferable share of, or voting trust certificate or certificate of deposit for, an equity security, interest in a joint venture, or certificate of interest in a business trust; in each such case, without regard to whether any such instrument is transferable, is classified as stock or anything similar, or confers voting power or voting rights;
(B) Any capital or profit interest in an entity;
(C) Any instrument convertible, with or without consideration, into any share or instrument described in paragraph (d)(2)(i)(A), or (B) of this section, any future on any such instrument, or any warrant or right to purchase, sell, or subscribe to a share or interest described in paragraph (d)(2)(i)(A), or (B) of this section, regardless of whether characterized as debt;
(D) Any put, call, straddle, or other option or privilege of buying or selling any of the items described in paragraph (d)(2)(i)(A), (B), or (C) of this section without being bound to do so, except to the extent that such option or privilege is created and held by a third party or third parties without the knowledge or involvement of the reporting company; or
(E) Any other instrument, contract, arrangement, understanding, relationship, or mechanism used to establish ownership.

Any person owning 25% or more of a reporting company's ownership interest is included among the reporting companies "beneficial owners."

Definition of Substantial Control

The second prong of the definition of "beneficial owner" includes any person who has "substantial control" over the reporting company.

FinCEN's regulations define "substantial control" as:

(1) Substantial control— (i) Definition of substantial control. An individual exercises substantial control over a reporting company if the individual:
(A) Serves as a senior officer of the reporting company;
(B) Has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body);
(C) Directs, determines, or has substantial influence over important decisions made by the reporting company, including decisions regarding: (1) 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; (2) The reorganization, dissolution, or merger of the reporting company; (3) Major expenditures or investments, issuances of any equity, incurrence of any significant debt, or approval of the operating budget of the reporting company; (4) The selection or termination of business lines or ventures, or geographic focus, of the reporting company; (5) Compensation schemes and incentive programs for senior officers; (6) The entry into or termination, or the fulfillment or non-fulfillment, of significant contracts; (7) 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; or
(D) Has any other form of substantial control over the reporting company.

As a result, a person has "substantial control" (and is therefore a beneficial owner) if that person:

1. Is a senior officer of the reporting company (subsection (i)(A));

2. Is able to appoint or remove any senior officer, or a majority of the board of directors of, the reporting company (subsection (i)(B));

3. Has "substantial influence over important decisions made by the reporting company" (subsection (i)(C)), or

4. Has "any other form of substantial control over the reporting company" (subsection (i)(D)).

Applying the Definition of "Substantial Control"

Because the definition of substantial control is a non-exclusive list of examples, and there is no safe harbor by which to exclude any person, reporting companies should consider interpreting the definition broadly.

For example, although the definition does not identify each member of a corporate board as having substantial control, most corporate board members have "substantial influence over important decisions" and therefore would likely fall into the definition through subsection (i)(D).

For limited liability companies where members must vote to approve major decisions, it is likely that each member will have substantial control over the reporting company by virtue of their voting power.

Each reporting company will have different concerns based upon its constituent documents. As a result, most reporting companies should seek legal advice when trying to determine who is a beneficial owner by virtue of the substantial control test.

About The Author

Jonathan Wilson is the co-founder of FinCEN Report Company with 31 years of experience in corporate, M&A and securities matters. He is the author of The Corporate Transparency Act Compliance Guide (to be published by Lexis Nexis in the summer of 2023) and the Lexis Practical Guidance Practice Note on the Corporate Transparency Act.

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