Board Members and Beneficial Owners
A reporting company that is preparing its first beneficial ownership information report (BOI report) under the Corporate Transparency Act (CTA) should consider whether it should identify each of its board members (or members of the board of directors) as beneficial owners. Although FinCEN’s regulations do not require a reporting company to list every member of the board as a beneficial owner, there are some practical considerations that weigh in favor of that practice.
What is a Beneficial Owner?
Under the CTA, a reporting company must disclose each of its beneficial owners. A
beneficial owner is any individual who directly or indirectly either (a) owns 25% or more of the ownership interest in the reporting company, or (b) exercises substantial control over the company.
Members of a company’s board of directors do not automatically exercise substantial control by virtue of their role as directors. No provision in 31 CFR 1010.380 mandates that a reporting company list every board member. FinCEN’s
FAQ D.9. expressly states that a member of a reporting company’s board of directors need not always be identified as a beneficial owner.
And yet, there is no provision in FinCEN’s regulations that describes the circumstances under which a director should be identified. Subsection (C) of the definition of “substantial control” provides that an individual has substantial control (and is therefore a beneficial owner) if that individual “has substantial influence over important decisions made by the reporting company.” But what does that phrase mean?
The Meaning of “Substantial Influence Over Important Decisions” in Relation to Identifying Beneficial Owners
FinCEN’s regulations do not give meaning to the phrase “substantial influence over important decisions.”
Some lawyers have taken the position that a director should only be designated as a beneficial owner if that director has the sole or primary power either to veto or to approve an important decision.
One
law firm memo, for example, suggested that a reporting company should, “include all members of the board . . . . unless: (i) it is obvious that only certain directors control the decision-making and that other directors have little influence . . . or (ii) the board is completely eclipsed by a domineering president or CEO, rarely meets, and does what it is told to do . . . “
FinCEN’s list of Frequently Asked Questions provide no help. FinCEN has published FAQs to provide illustrations, but the FAQs “are explanatory only and do not supplement or modify any obligations imposed by statute or regulation.” FinCEN’s FAQ D.9. merely says that “whether a particular director meets any of these criteria [of substantial control] is a question that the reporting company must consider on a director-by-director basis.” That conclusion follows the regulation, but where does it lead? On what basis should a reporting company conclude that a particular director is, or is not, in possession of “substantial influence?”
In other words, under what circumstances is a board member a beneficial owner by virtue of the “substantial influence” test?
Interpretations that suggest identifying only a board member who has dispositive power or veto power create a bright line test, but are unsupported by the regulation. The regulation does not say that a board member is a beneficial owner only when the board member has the power to determine or veto an important decision. The regulation refers to “substantial influence” over an important decision.
Likewise, a test that requires counsel to examine past board decisions to divine whether individual board members “control the decision-making” is also unsupported by the regulation. There is nothing in the regulation to say that a “controlling” board member is a beneficial owner, but a “passive” board member is not. There is also nothing in the regulation that states that a passive board under the control of a “domineering president or CEO” are not beneficial owners.
Not only are these interpretations unsupported by the regulation, but they require an inherently subjective exercise. There is no objective test for when one director acts independently, but another acts passively. This lack of regulatory guidance is particularly acute when you consider the impact of guessing wrong.
In a prosecution over a potentially defective BOI report, the defendant will argue that it engaged in a an earnest and judicious weighing of facts and circumstances. The prosecutor will urge that the same facts merely demonstrate the defendant’s willful connivance and manipulation. A defendant who needs to prove the absence of a “willful” failure to disclose will be hard-pressed to obtain a pre-trial dismissal even with the most robust documentation of an honest internal decision process.
Hints From FinCEN’s Discussion on “Substantial Influence”
In other contexts, lawyers interpreting FinCEN’s regulations have examined FinCEN’s discussion of its regulations from the September 2022 release for hints as to staff’s intentions.
In its discussion of the “substantial influence” prong of the substantial control test, FinCEN
wrote (emphasis added):
“The final rule also retains the ‘substantial influence’ language in the third indicator, because FinCEN envisions situations in which individuals
may not have the power to direct or determine important decisions made by the reporting company,
but may play a significant role in the decision-making process and outcomes with respect to those important decisions. . . . . A reporting company may also 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.”
This text suggests that the drafters of the regulation viewed a director with “substantial influence over important decisions” as one with a “significant role” even if that individual lacked the power to “direct[s] or determine[s]” the decision.
And, where a board is composed of a group of directors that have “essentially equal authority” then “each individual would likely be considered to have substantial influence.”
A Conservative Approach to Disclosing Directors as Beneficial Owners
The lack of a rubric for determining which directors have substantial influence over important decisions suggests a conservative approach. If there is no regulatory safe harbor to exclude a particular director, then the only risk-free rule is one that includes all directors.
In this light another law firm,
Perkins Coie, reached the same conclusion:
“In light of the ambiguities under these rules, particularly as to the reporting of directors, there may be genuine disagreements between individuals and reporting companies as to whether the reporting of a particular individual is required. As noted above, the most conservative approach will likely be to report in the absence of certainty.”
Conclusion Regarding Reporting Directors as Beneficial Owners
More than 32 million companies will need to file an initial BOI report before the end of 2024. FinCEN’s regulations do not provide a clear test to determine which board members should be included as beneficial owners. The lack of a regulatory test for excluding some board members who lack substantial influence suggests that the most prudent approach is to list every board member as a beneficial owner.
