Understanding "Substantial Control" Under the CTA

The Corporate Transparency Act (CTA), passed as part of the Anti-Money Laundering Act of 2020, marks a significant development in corporate governance and financial transparency within the United States. A cornerstone of the CTA is its requirement for certain business entities to disclose their beneficial owners to the Financial Crimes Enforcement Network (FinCEN) via a beneficial ownership information (BOI) report. This article delves into the concept of "substantial control" as it relates to beneficial ownership under the CTA.

The Importance of Beneficial Ownership Transparency

The CTA is designed to combat illicit activities, including money laundering, terrorism financing, and tax evasion, by enhancing transparency in corporate ownership structures. The Act mandates that companies report their beneficial owners, defined as:

1.      individuals who exercise substantial control over the company or

2.      individuals who own or control at least 25% of the company's ownership interests.

Defining "Substantial Control"

"Substantial control" is a critical element in identifying a beneficial owner under the CTA. It refers to an individual's ability to influence significant aspects of a company’s operations and decision-making processes. The CTA outlines specific criteria for determining whether an individual possesses substantial control.

An individual exercises substantial control over a reporting company if the individual meets any of the four general criteria:

(1) the individual is a senior officer (which the regulations define as any individual holding the position or exercising the authority of a president, chief financial officer, general counsel, chief executive officer, chief operating officer, or any other officer, regardless of official title, who performs a similar function);

 (2) the individual has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body);

(3) the individual directs, determines, or has substantial influence over important decisions made by the reporting company, including decisions regarding:

(a) 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;

(b) The reorganization, dissolution, or merger of the reporting company;

(c) Major expenditures or investments, issuances of any equity, incurrence of any significant debt, or approval of the operating budget of the reporting company;

(d) The selection or termination of business lines or ventures, or geographic focus, of the reporting company;

(e) Compensation schemes and incentive programs for senior officers;

(f) The entry into or termination, or the fulfillment or non-fulfillment, of significant contracts;

(g) 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

(4) the individual has any other form of substantial control over the reporting company.

Also, the FinCEN rules state that a reporting company may be structured such that multiple individuals exercise essentially equal authority over the entity's decisions—in which case, each individual would likely be considered to have substantial influence over the decisions even though no single individual directs or determines them. This approach is consistent with the other prong of the CTA's “beneficial owner” definition (i.e., ownership or control of at least 25 percent of the entity's ownership interests), which recognizes that something short of majority ownership can still be indicative of beneficial ownership of a reporting company.

**Important Note: Substantial control can arise indirectly.  The regulations state that an individual may “directly or indirectly, including as a trustee of a trust or similar arrangement, exercise substantial control through”:

(1) Board representation;

(2) Ownership or control of a majority of the voting power or voting rights of the reporting company;

(3) Rights associated with any financing arrangement or interest in a company;

(4) Control over one or more intermediary entities that separately or collectively exercise substantial control over a reporting company;

(5) Arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees; or

(6) any other contract, arrangement, understanding, relationship, or otherwise.

Therefore, you must identify as beneficial owners not only those individuals with direct substantial control of the reporting company, but also those individuals who possess substantial control indirectly.  For example, suppose another entity (for example a General Partner set up as a limited liability company) exercises control of a reporting company. In that case, the individuals in control of the General Partner LLC will also be treated as individuals with substantial control over the reporting company and, therefore, should be listed as beneficial owners.

Implications for Reporting and Compliance

The CTA's broad definition of substantial control carries significant implications for companies subject to its reporting requirements. Businesses must carefully evaluate their ownership and governance structures to identify all individuals who meet the criteria for substantial control, and must amend their BOI reports timely when these people change. Accurate reporting of these individuals is crucial, as non-compliance can lead to severe penalties, including substantial fines and potential criminal charges.

As regulatory expectations evolve, staying informed about compliance requirements is essential for businesses of all sizes.