Complying with Beneficial Ownership Reporting Rules

Complying with Beneficial Ownership Reporting Rules

Complying with Beneficial Ownership Reporting Rules

1000 648 David Hoppe

The Financial Crimes Enforcement Network (FinCEN) has adopted stringent regulations aimed at curtailing use of small business entities as shell companies used by criminal elements to fund global terrorism, launder money, evade taxation, and conduct a host of other illegal activities.

Most small businesses registered in the U.S., including video game developers and publishers and other Web3 businesses, must report “beneficial ownership.” Failure to report accurately and on time can subject technology companies to civil and criminal punishment. FinCEN’s efforts to preserve the integrity of the US business environment and uphold the nation’s commitment to international standards set by bodies like the Financial Action Task Force (FATF) and the Organization for Economic Co-operation and Development (OECD) also make it more difficult for investor activists and unsolicited bidders to accumulate the shareholder influence needed to carry out their designs.

Emerging Tech Companies Beware

However, they may also impose additional hardships on emerging technology companies that use complex and alternative compensation structures and business dealings to raise funds and reward employees. These schemes may obscure which individuals in fact own enough of a firm or exert sufficient influence to accrue beneficial ownership interest. While discovering who holds ultimate responsibility for a company’s actions, the new reporting laws foster better decision-making and accountability. They also facilitate legitimate business activities, thereby fostering investor confidence and easing cross-border trade and investment.

But they unquestioningly present difficult hurdles for Web3 firms to overcome. Identifying and disclosing who holds substantial control or ownership over these kinds of companies is especially daunting for two primary reasons:

  • Complex Ownership Structures – Tech companies often organize themselves along intricate corporate structures with multiple layers of holding companies, investors, and shareholders. This complexity.
  • Ambiguity in Definitions – The terms “beneficial ownership and “ownership interest” are subject to interpretation, leading to confusion and inconsistent application. These terms could encompass a wide range of interests, including revenue sharing agreements, management agreements, convertible debt, joint ventures, and even publishing deals.

Video game developers, application platforms, media distributors, and content producers may enter revenue sharing agreements with publishers, advertisers, and investors. Businesses may differ with regulators whether these stakeholders wield enough power to constitute ownership interest. Token sales and initial coin offerings, the sale of non-fungible tokens, subscription-based models, compensation for content sharing, staking, and yield farming are just some of the arrangements decentralized finance and other blockchain businesses may employ that complicate adequate reporting.

Who Must Comply?

While officers and boards of directors of corporations and LLCs obviously reap the benefits of ownership, the requirements could also extend to people who stand to gain financially from the profits generated by the sale of products and services by businesses with which they are affiliated. The new statute specifically states that mere financial exposure to a company’s performance does not make someone a beneficial owner. It also stipulates that holders of non-security-based swap (SBS) cash-settled derivatives could be considered beneficial owners if they meet certain criteria. Parties to revenue- or profit-sharing agreements also could be responsible for filing beneficial ownership reports.

FinCEN suggests that most sole proprietorships and general partnerships are likely exempt as they typically don’t require a formation document. The National Law Review notes that more than tech companies be exempt if they “are already subject to some sort of government oversight, such as public companies, banks, public utilities, tax-exempt nonprofits, and insurance companies.”

Businesses that cannot qualify for an exemption could face significant burdens that could be both costly and disruptive. They will need to disclose personal information about anyone who substantially controls or owns their companies. This will necessitate accurate recordkeeping and timely disclosure. Legal assistance may aid in making optimal and compliant decisions about when to file the reports and who to include as beneficial owners.

How to File

Reporting companies formed on or after January 1, 2024, will need to file the report within 30 days. Companies formed earlier have between one year from January 1, 2024, to get the report submitted.

The beneficial ownership report asks for certain information about your reporting company, including its legal name, any “doing business as” names, business address, tax ID number, jurisdiction, and date of formation.

The key part is providing the personal information of each of the company’s “beneficial owners.” This includes any individual who owns 25% or more of the ownership interests in your reporting company. It also includes those who directly or indirectly control or manage the company.

For each beneficial owner, you’ll need to provide their full legal name, birth date, residential address, and an identifying number from a passport, state ID or driver’s license. You’ll also need to attach an image of the ID document.

FinCEN is creating an online filing system that will open on January 1, 2024. Filings will be submitted electronically through FinCEN’s website. There is no fee to file the beneficial ownership report.

Take the next year to ensure you have all the information ready about your reporting company and its beneficial owners. This will make the filing process smooth once the system opens. Revisit any ownership changes over the past year to see if new beneficial owners need to be added.

Activism and Takeovers

The new rules will significantly impact activist investors and hostile acquirers. By requiring more frequent and detailed disclosures once an investor’s stake exceeds 5%, the rules aim to provide more transparency and prevent secret accumulations of shares. However, this will also make it harder for activists and hostile bidders to quickly amass large stakes.

Previously, investors had 10 calendar days after crossing the 5% threshold to file a Schedule 13D, allowing more time to continue buying shares without disclosing their plans. Now the filing deadline is just 5 business days. This gives activist funds much less time to build up their positions before going public. As a result, they may struggle to acquire enough shares to exert the influence they desire. The compressed timeframe also means demand for the company’s stock will be condensed, likely increasing the price activists have to pay.

In addition to the reduced accumulation period, activists will probably have to pay higher prices for shares purchased after filing the Schedule 13D. Once their intentions are known, the target company’s stock price often rises in anticipation of a shake-up. Hence, the blended cost of a toehold stake could become prohibitively expensive for some activist funds. This may discourage campaigns against certain companies.

Activist investors sometimes tip off allies to accumulate shares in the target company, forming a “wolf pack” to increase their influence. But under the new rules, communicating plans to file a Schedule 13D could constitute a “group” for reporting purposes. This would force members to file as well, eliminating the element of surprise. Since banding together will be harder, activists may have fewer supporters or be less willing to risk forming groups.

With more frequent filing requirements for passive institutional investors, target companies will get an earlier warning when their shareholder base begins to shift. They’ll have more time to implement defenses before activist stakes become too large to fend off. Companies may also use the quarterly updates to regularly monitor changes in their investor profile and engage with shareholders proactively. This will allow them to identify and head off activist threats sooner.

Overall, while determined activist funds will still wage campaigns under the new regime, the reporting rules will pose some clear disadvantages. The costs and difficulties of quickly building significant ownership positions could frustrate certain strategies and force adaptations. This may lead to fewer proxy fights or hostile takeovers in some cases. However, activists with ample capital can likely overcome these hurdles if the target company merits the effort and investment required. Though accumulating stakes will be harder, the most motivated funds will find ways around the new obstacles.

An attorney specializing in Web3 businesses and with experience in securities and investment law can provide valuable assistance in assuring compliance with the new regulations.

Gamma Law is a San Francisco-based Web3 firm supporting select clients in complex and cutting-edge business sectors. We provide our clients with the legal counsel and representation they need to succeed in dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.


David Hoppe

All stories by: David Hoppe

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