Beneficial Ownership Reporting Cancelled, Bringing Regulatory Relief for Alternative Investment Fund Managers

EFSI got its start in the emerging hedge fund manager space, one where we still have a significant focus (not to mention a terrific client roster!) so, whenever I see something in the news that might provide a little help to the next Ray Dalio or William Ackman, I tend to find myself agreeing with it (usually).

That was certainly the case when the SEC’s planned private funds regulation got overturned last summer, to give just one example.

And the latest sigh of relief came earlier this month, when the U.S. Department of the Treasury announced that it will not enforce the Corporate Transparency Act (CTA) against U.S. citizens and domestic reporting companies. This decision brings a profound sense of relief to the alternative investment industry, which had been grappling with the potential implications of the CTA’s beneficial ownership reporting requirements.

Enacted in 2021, the CTA aimed to enhance financial transparency by mandating that corporations, limited liability companies, and similar entities disclose their beneficial owners to the Financial Crimes Enforcement Network (FinCEN). While the act sought to combat illicit financial activities, it also posed significant compliance challenges – and costs – for various sectors, notably the alternative investment industry.

Given the alternative investment industry operates through complex structures involving multiple entities, the CTA’s reporting requirements threatened to impose substantial administrative burdens on these firms. Compliance would have necessitated meticulous tracking and reporting of beneficial ownership across numerous entities, diverting resources from core investment activities and potentially exposing sensitive information.

Moreover, the industry’s reliance on confidentiality as a cornerstone of investor relations could have been undermined. Investors often prefer discretion regarding their holdings, and the CTA’s mandates risked eroding this trust, potentially leading to reduced capital inflows and stifled innovation within the sector.

While the suspension of enforcement provides immediate relief, the Treasury also indicated plans to issue a proposed rulemaking that would narrow the scope of the CTA to foreign reporting companies only. This prospective change aims to balance the necessity of combating illicit financial activities with the need to foster a conducive environment for domestic enterprises.

So, a ‘win’ here, especially for newer and emerging managers in terms of regulatory red tape. But what I’m curious about is whether this will impact capital raising going forward. If the CTA applies only to foreign entities, investors might view U.S. fund managers as a more attractive option due to reduced regulatory burdens and confidentiality concerns.

The alternative investment industry thrives on discretion, and investors – especially high-net-worth individuals and family offices – value confidentiality. If foreign fund managers are subject to more stringent transparency requirements under the CTA while U.S.-based managers are exempt, some investors may favor U.S. funds to avoid additional disclosure risks, even if these disclosures are not available to the public.

Furthermore, investors often assess regulatory environments when allocating capital. If U.S. fund managers operate with fewer compliance obligations compared to their foreign counterparts, they may gain a competitive edge, particularly among investors who prioritize efficiency and reduced reporting burdens.

There are counterpoints, of course. One would imagine that larger, public institutional investors have to report considerable amounts of information publicly, and often have their own internal transparency requirements and may not be deterred by foreign fund disclosures.

Many investors diversify across jurisdictions for tax and regulatory reasons, so the CTA’s impact alone may not be enough to shift capital flows dramatically. And other jurisdictions (e.g., the EU) already have strong transparency rules, so sophisticated investors might not see the CTA as a major differentiator.

So, while the CTA’s limited scope could tilt the playing field slightly in favor of U.S. fund managers, it’s difficult to tell – at least, at the moment – whether this might be a game-changer in terms of capital raising. What it does do is provide a little regulatory relief, which impacts the smaller and emerging part of the market more than the mega funds.

Whether anything changes in the medium term is anyone’s guess. But, as I say, in the short term, those legal bills might not be as high as they looked to be just a couple of months ago.

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Anthony D. Mascia is Managing Partner at EFSI. Connect with him on LinkedIn here.

EFSI is an independently owned, SOC-1 compliant, full-service fund administration firm. We provide accounting, reporting, administrative, and capital introduction services to a wide range of alternative investment funds including hedge funds, funds of funds, private equity funds, real estate funds, venture capital funds, and family offices. The center of EFSI’s service incorporates resilient technology and accomplished staff, providing clients a tailor-made service with exhaustive transparency. Give us a call today or reach out to our support team online. We look forward to hearing from you soon.