What your organization needs to know about the new FinCEN Report 114
The new and improved FinCEN Report 114 is the form to use to report foreign financial account activity to the U.S. government. Nonprofit organizations may find themselves within this reporting regime if they operate overseas and have bank accounts in those locations. In addition, as nonprofit organizations advance their missions and build their endowments, the types of investments nonprofit organizations are associated with are getting more and more complex. The complexities associated with nonprofit activities, accounts and investments cause various rules to apply in determining what must be reported on FinCEN Report 114. In particular, questions often arise as to when an alternative investment meets the definition of a reportable item.
When determining if an interest in an alternative investment requires reporting on FinCEN Report 114, the investor must look to the fund's nature to determine if it falls within the regulatory definition of those accounts and/or investments which require disclosure. There has been particular debate recently concerning the reporting of hedge funds and other alternative investments that could potentially fall within the definition of "other financial accounts" and thereby generate a filing obligation. In determining the classification of a fund and if an interest in it requires reporting, it is helpful to examine the documents provided by each specific fund that delineate its nature. Such documents typically provided to the investor may include the supplemental disclosure statement (Statement) and the subscription agreement (Agreement), which provide the terms for the purchase of shares in the relevant fund.
When reviewing these documents, keep in mind that among the foreign financial accounts that generate a reporting obligation are bank accounts, securities accounts and those falling within the definition of "other financial accounts." Final regulations include within the definition of other financial accounts "an account with a mutual fund or similar pooled fund which issues shares available to the general public that have a regular net asset value determination and regular redemptions." This definition was issued in an attempt to clarify what types of accounts require reporting when they display qualities similar to those of mutual funds, particularly to help clarify whether reporting of hedge funds is required. Based on this definition of "other financial account," a hedge fund would be classified as a similar pooled fund and generate a FinCEN Report 114 reporting obligation only when the fund's shares 1) are available to the general public, 2) have a regular determinable net asset value, and 3) are subject to regular redemptions.
Upon reviewing all of the fund's documentation, one should be able to determine its classification, including whether it can be appropriately classified as a hedge fund, which should not require a FinCEN Report 114 filing unless stock from the fund is made available for sale to the general public, has a regular determinable net asset value, and is subject to regular redemptions.
If the fund is determined to be a hedge fund, there are specific provisions to look for in the Statement and Agreement that lend support to the position that there is no need for filing FinCEN Report 114 because all three requirements above are not met. First, the Agreement may elaborate on specific redemption procedures that limit the redemption qualities of its shares. For example, there could be a clause with a minimum lock-up period for certain classes of shares, while other classes have a minimum holding period limiting early redemptions to total redemptions of all shares in relation to market value. Second, a clause specifying that there is no market for the fund's shares or some similar detail could be present supporting the position that there is no regular determinable net asset value for the fund's shares. Finally, and likely more applicable to hedge funds held by nonprofit entities, there is the determination of whether the fund is available for sale to the general public. If purchasers are limited, the Statement provided by the fund should identify those "permitted persons" that are authorized to purchase fund shares. For example, some Statements issued by funds may limit permitted persons to either 1) U.S. persons exempt from federal income tax on passive income, or 2) other U.S. persons permitted by the fund or its delegates. The Statement could also specify that a determination of other U.S. persons eligible to purchase stock is made by the fund at its sole discretion. This document sometimes further provides that in order to purchase shares, individuals meeting the previous classification must have a substantive and pre-existing relationship with the fund, its investment manager, other representatives, a selling agent or a qualified finder.
Additional potential purchaser limitations could state that the potential investor must: 1) be an "accredited investor," 2) be a "qualified eligible person" under Rule 4.7 of the Commodity Futures Trading Commission, or 3) have requisite knowledge and experience in financial and business matters. The Agreement could also demonstrate additional evidence that the fund has limited the sale of its shares to certain parties. For example, noted in the Agreement may be the fact that the fund reserves the right to reject subscriptions in whole or in part for any reason and is not even required to provide a reason. Often, upon signing for the purchase of shares, the subscriber is agreeing to specific terms in the Agreement by which it warrants that it satisfies the suitability requirements and, specifically, that it falls within the definition of those permitted to purchase shares. The fund can further reserve the right to require other additional documentation before acceptance of the subscription and request detailed information regarding the purchaser's identity and legal classification to ensure compliance with purchaser guidelines. Finally, noted in the Agreement may be a clause stating that the subscriber may not sell, pledge, transfer, assign or otherwise dispose of the shares without the prior written consent of the fund's directors. All of this information lends support to the position that the Agreement for the purchase of the shares in question is not made available to the general public and likely does not generate a FinCEN Report 114 filing obligation.
Harsh penalties are involved for failure to submit a timely filed and complete FinCEN Report 114. Nonprofit organizations should continually make internal accountings of their foreign accounts and alternative investments to ensure that all disclosures necessary for a properly completed report are captured. For questions related to the FinCEN Report 114, please consult your tax advisor.