Doing Business in D.C.: Ownership Disclosure Required

By Jarrod Melson Monday, June 29, 2020
washington monumentAny corporation, limited liability company, or limited partnership that registers to do business in Washington, D.C. (or which should register but does not) must publicly disclose its direct and indirect greater than ten percent (10%) individual owners’ and controlling investors’ (regardless of percentage) names, residences, and business addresses. A company must disclose natural person owners, and also look through entity investors to find the ultimate natural person beneficial owner(s) of the entity. The D.C. Council approved this new measure in 2018, and it became effective January 1, 2020. 
 
This requirement, among similar initiatives in other states and on the federal level, (1) undermines the privacy rights Delaware affords the owners of businesses formed in the State, (2) will lead to a drop in doing-business filings in D.C., as more owners and investors will exploit the perceived ambiguity in whether a filing is required for their D.C. operations, and (3) will lead to less overall investment in the District as investors, wary of having their investments disclosed publicly, avoid investments in companies operating, particularly those operating exclusively or significantly, in the District. However, in the long run, whether the encroachment is state-by-state or the result of a broad federal mandate, the state and federal governments’ desire to have readily-available access to business ownership information, rather than going through existing judicial channels designed to prevent abuse and overreach, will likely win the day.  

The Threshold Question – Registered or Required to be Registered?

This article focuses upon the disclosure obligation and its attack on active and passive owners’ and investors’ much-valued privacy in operating a business or making an investment.  A discussion of when a company is required to register to do business in a state is beyond the scope of this piece, as the criteria triggering such an obligation are frequently unclear.  
 
For example, D.C. law does not provide guidance on what activities or level of involvement in the District triggers an obligation to register to do business there; instead, D.C. law provides examples of activities that would not require registration, such as, among others, (1) maintaining financial accounts with businesses in the District (e.g., trust accounts, bank accounts, brokerage accounts), (2) selling goods through independent contractors in the District, (3) providing mortgage loans to home buyers in the District, and (4) conducting board or shareholder meetings within the District.  
 
Would a company offering intangible services through a public website directed at businesses or the public generally, including those in the District, trigger registration? Would the registration requirement depend upon the size of the customer base in the District and, if so, what level of activity triggers the obligation? A company concerned with material business connections to the District should consult on attorney to assess whether a doing business registration is require under their particular circumstances.
 
We at Harvard Business Services have written a number of general posts on when a business incurs an obligation to file a foreign qualification to do business in various states.

Required Disclosures

Entities formed in the District, or which are formed elsewhere but do business in the District such that registration is required, must disclose their ownership and related information to a city agency, which makes that information publicly available.1   Entities subject to the requirement must update the information in their disclosures as that information changes and, in the case of entities formed outside the District, at the time of making their biennial report to the Mayor. 
 
A subject business entity is required to disclose the name, residence, and business address of:
  • Owners holding more than ten percent (10%) its shares of interests, or shares or interests entitling the holder to receive more than ten percent (10%) of the entity’s economic distributions or to exercise more than ten percent (10%) of total voting rights2
     
  • An entity or individual owning ten percent (10%) or less of such interests, but that:
    • Controls the financial or operational decisions of the entity, or
    • Has the ability to direct the day-to-day operations of the business entity. 
If the ultimate natural person individual owner holds its interest through one or more intermediate holding companies, the analysis must be performed on each entity up the chain until the name of one or more persons is disclosed for each owner or investor meeting the criteria above, even very indirectly.
 
The beneficial ownership determination is notoriously difficult given the near-infinite permutations of economic and governance arrangements within an entity.  This flexibility is particularly apparent in the case of LLCs, which, as creations of contract, allow members to customize any terms they wish to fit their agreed-upon arrangements. A fixed percentage threshold seems like an easy dividing line, but how are multi-class structures, where each class has different rights and obligations, counted for purposes of percentage ownership or control?  How are very disparate classes with disparate fixed or contingent rights to voting or distribution handled?  In the case of restricted stock or convertible securities, is the calculation based on a fully-diluted, as-converted basis?  In the second, control-focused, analysis, what constitutes “control” or “directing the day-to-day operations” of a business entity?  For example, if an investor has the ability to veto certain key decisions proposed by management, when do these veto rights amount to “control”?  
 
Beneficial ownership is difficult enough in a single entity, but becomes even harder when one is forced to look through entity owners of a business entity, which may themselves have multiple owners, some of which may be entities, and which may have varying arrangements and classes of interest with different powers. Absent complex instructions and implementing rules, as one sees in instances where the U.S. Securities and Exchange Commission has attempted to define beneficial ownership, the variety of potential economic and governance arrangements can make, what upon first examination appears to be a simple filing, very ambiguous.

Conclusion

Delaware treats information regarding the governance and ownership of businesses formed in or doing business in the State as private to a business and its owners, absent a subpoena or other compelling order.  However, business owners’ and investors’ privacy rights are under attack at both the state and federal in the form of greater ownership disclosure requirements. Certain states are taking the same approach as the District.
 
Originally intended to apply to entities that owned residential buildings in the District, the measure was expanded to all entities with a “why not?” attitude and as part amendments intended to convert the tenant-protection measure into a fee-generating requirement. At the federal level, ill-conceived legislation (see our post on the Corporate Transparency Act of 2019) would compel complex beneficial owner disclosures from virtually all U.S. companies, with potentially draconian measures for non-compliance. 
 
Proponents of these disclosures claim that criminals and bad actors hide behind the “anonymity” of business entities; but the resulting burdens fall upon American small businesses and their overwhelmingly law-abiding founders and owners, all to save the government the time and effort required to go through the existing judicial review processes to obtain a subpoena for ownership information. 
 
While cash-strapped small businesses hire attorneys to parse through complex disclosure requirements with potentially harsh penalties, one is left to wonder if the intended targets of ownership disclosures oft-cited by proponents – human-traffickers, drug cartels, and other bad actors – will similarly go through such efforts to provide accurate and up-to-date information in the required filings to justify the intrusion to the privacy of the masses.

[1]     See D.C. Code, Title 29, Chapter 1, Subchapter II, Secs. 29-102.1 and 29-102.11 (“D.C. Code 29-102”). Entities formed outside of the District must provide the required disclosures in their biennial report to the Mayor of the District.

[2]     The language relating to economic distributions and voting rights is somewhat ambiguous, described as more than ten percent (10%) “governance” interest or “total distributional interest” of the business entity. See D.C. Code 29-102.11(a)(6).

*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.

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