The control and beneficial ownership of real estate in the U.S. has been relatively easy to conceal.

With the use of typical investment vehicles — including corporations, limited partnerships, limited liability companies, trusts and commingled funds — and of multiple, layered and often multijurisdictional tiers of entities, it has been difficult and sometimes impossible for governmental entities to identify the actual beneficial owners and control parties of real estate.

The limited transparency of real estate ownership and control has been an attractive feature of ownership of U.S. properties, and has simplified the administrative burden of management of entities in the real estate space. Some investors have a preference for privacy that is defensible and, to date, with some exceptions, has been completely legal. But there is a concern that money from criminal or terrorist sources can be channeled into real estate investments.

This disclosure regime is about to change dramatically. All parties involved in real estate capital formation and investment will have to track and adapt to the new regime.

Due to concerns over terrorism and money laundering, the U.S. government has increasingly focused on means to effect disclosure. The USA PATRIOT Act created a registry of individuals and entities with whom commercial contact is prohibited.

The U.S. Department of the Treasury's Financial Crimes Enforcement Network imposed on financial institutions extensive know-your-customer requirements under the customer due diligence rule. Also, FinCEN adopted geographic targeting orders requiring disclosure of beneficial ownership of residential property purchases in targeted urban areas.

Critics both within and outside the U.S. have characterized this disclosure regime as inadequate. As one high-profile example, the Financial Action Task Force, a worldwide intergovernmental body of which the U.S. is a member, characterized the U.S. requirements for disclosure of control and beneficial ownership of nonfinancial entities as noncompliant with its recommendations.

Conversely, financial institutions criticized the compliance costs and compliance strictures imposed on them as gatekeepers in the anti-money laundering and counter-financing of terrorism arena.

After interested parties grappled for several years with conflicting proposals, the logjam broke with the enactment of the Corporate Transparency Act. On Jan. 2, Congress overrode then-President Donald Trump's veto of the National Defense Authorization Act for fiscal year 2021, or H.R. 6395, which included the CTA.

The CTA places the burden on reporting companies which, unless exempted, must report their principal direct and indirect individual beneficial owners and control parties to a beneficial ownership registry to be created and maintained by FinCEN. The registry will not be publicly accessible, but its information may be shared by FinCEN with certain U.S. and foreign governmental entities, including for tax compliance, and, with the consent of the disclosing party, with financial institutions.

The willful failure to provide complete information, initially or in an update, or the willful provision of false or fraudulent information is subject to civil and criminal fines and penalties — fines of up to $500 per day, criminal fines of up to $10,000 and/or imprisonment of up to two years. It is not clear who will be subject to prosecution, or how assertive FinCEN can or will be in seeking information from targets other than the reporting company.

The CTA contains only the skeleton of the new compliance regime, with numerous unresolved questions and ambiguities. The CTA instructs the Treasury to issue implementing regulations within one year, and the CTA requirements will not become effective or fully comprehensible until that time.

The definition of "reporting companies" is preliminary. Corporations, limited liability companies and similar entities must comply, unless exempted. It is widely expected that limited partnerships will be deemed similar, and perhaps business trusts, but the regulations will govern. Foreign entities are not reporting companies unless qualified to do business in the U.S., but reporting regarding foreign persons is required.

Many classes of entities are exempted, including public companies registered under the Securities Exchange Act, pooled investment entities operated or advised by certain designated types of entities, insurance companies, not-for-profit entities and broker-dealers. One broad exemption applies to U.S. entities owned or controlled by U.S. persons, with a physical presence in the U.S., $5 million of gross receipts or gross sales, and at least 20 full-time employees. It is not clear whether newly formed entities can obtain this latter exemption.

Reporting companies must disclose the name and birth date, current address, passport number or driver's license, or comparable information of any U.S. or foreign individual who, directly or indirectly, by contract, relationship, understanding or otherwise exercises substantial control over or owns or controls 25% or more of its beneficial interests.

Exempt entities must be identified if their ownership or control of a reporting company satisfies the above definition. These requirements spread a net whose extension is potentially breathtaking, and whose terms are imprecise and ripe for controversy. For example:

  • How is percentage ownership determined in entities with complex capital stacks? How are tiered returns, promotes or contingent payments taken into account? Are there attribution rules among families or related companies?
  • What is substantial control? Is an asset manager or a lender with decision rights and/or an equity-flavored return covered? What is control, where decision making is diffuse? How does FinCEN propose to balance day-to-day management and major decision rights?

FinCEN and reporting companies may disagree as to the scope of disclosure. So may sponsors and investors, corporate boards and shareholders, lenders and borrowers, and limited liability company members among themselves. Perhaps the regulations will add clarity.

The CTA prohibits the issuance of bearer instruments to evidence ownership in reporting entities. The status of existing bearer instruments is not clarified.

The CTA's requirements are inconsistent with the existing requirements imposed on financial institutions by the know-your-customer prescriptions under the customer due diligence rule. The CTA expressly requires that the customer due diligence rule be conformed. Perhaps financial institutions will be allowed to rely on the CTA database in lieu of collecting their own information.

Entities in existence when the regulations take effect must file beneficial ownership statements within two years after the effective date of the regulations. Entities formed after the effective date must make their initial filing on formation. All entities that have filed will have to report material changes within one year after the changes become effective.

Unclear is how reporting will work in common situations where entities are formed before they have ownership or assets in place. This process will involve cooperation by the agency of each state that regulates entity formation.

The regulations will clarify many issues, of course, but initial planning would be appropriate. Planning will be complicated because the interests of the parties may conflict. Among other things, who decides what information has to be disclosed? Who is required to make filings? Who indemnifies who for liabilities arising from alleged noncompliance?

  • Sponsors of and investors in existing investment vehicles will want to determine whether or not the vehicle is exempt. If bearer instruments have been issued, the effect of the CTA should be analyzed.
  • Sponsors should consider requiring prospectively the compliance of investors with the CTA and perhaps indemnifications for noncompliance. Since the reach of CTA provisions is as yet undefined, who makes determinations as between management and investors? How does management avoid a willful breach if investors refuse to comply or are not truthful? Is indemnification sufficient as a remedy? Might there be a way for investors to provide sensitive information directly to FinCEN? The CTA provides some guidance in these areas, including provisions for safe harbors in disclosure and for individuals to use FinCEN identifiers in lieu of other personal information, which regulations will clarify.
  • Lenders may add requirements for compliance with the CTA and consent to CTA disclosures in their loan documents. Should lenders worry that control rights in the loan documents or upon default or bankruptcy make them a beneficial owner? Or equity-flavored returns? And lenders should be alert to upcoming changes to the know-your-customer requirements of the customer due diligence rule.
  • Attorneys may be concerned with the legal ethics issues that are raised, and their potential liability under the CTA for taking part in the creation of new entities. For example, is an incorporator or organizer of an entity an applicant or beneficial owner liable for noncompliance? If so, is that individual released when the intended owners and control parties are installed? Will attorneys assist in preparing reports to the database? What are their ethical duties to disclose if they suspect that the information is incorrect, or they disagree with the decision as to what information must be disclosed? Will corporate service companies have similar issues?
  • Will compliance with the CTA constitute a breach of privacy laws of the U.S. or other countries, or the confidentiality provisions of existing documents?
  • The CTA binds FinCEN to strict rules as to the use and confidentiality of information reported to the database. However, is information it shares with local and foreign governments equally secure? Given recent hacks of federal databases, is any of this information secure?
  • Will information collected and reported by a reporting company be protected against discovery in litigation in which the reporting company is a party?
  • Are there planning tools that can be used in response to the new requirements?

This is just a preliminary analysis of the CTA and its ramifications. More will come as time passes and when the regulations are issued.

This article was originally posted in Law360 on February 10, 2021.