On March 1, 2024, the United States District Court for the Northern District of Alabama declared the Corporate Transparency Act (“CTA”) unconstitutional. Enacted as part of the Anti-Money Laundering Act of 2020, the CTA requires certain legal entities to report beneficial ownership information (“BOI”) to the U.S. Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”). The reporting provisions took effect on January 1, 2024. In National Small Business United v. Yellen (5:22-cv-01448-LCB), the District Court, in a memorandum opinion, rejected the Government’s position when it held that the CTA exceeds Congress’ power to regulate these business entities. The Court issued a Final Judgment on March 1st as well, permanently enjoining enforcement of the CTA against the two plaintiffs.
Pending appeal, it is not clear whether the government will continue to enforce the CTA against non-parties to the lawsuit, or what other impact this ruling will have nationally on entities subject to the CTA’s reporting requirements. McGuireWoods will be closely monitoring developments.
Background
Plaintiffs, an Ohio non-profit corporation representing small businesses across the United States and an individual who is a member of this non-profit and a small business owner subject to the reporting provisions of the CTA, sued the Treasury Department, along with Treasury Secretary Janet Yellen and Acting Director of FinCEN Himamauli Das in their official capacities, alleging that the CTA’s mandatory disclosure requirements exceed Congress’ authority under Article I of the Constitution and violate the First, Fourth, Fifth, Ninth, and Tenth Amendments. (Id. at 4). The parties cross-moved for summary judgement in early 2023, and the Government simultaneously moved to dismiss the action. (Id.).
The CTA is not Within Congress’ Powers to Oversee Foreign Policy
First, the Government contended that the Constitution’s Necessary and Proper Clause conferred authority to Congress to enact the CTA under its foreign affairs powers. (Id. at 16). The District Court rejected this contention, holding that here, Congress was bound by the Constitution’s enumerated powers limitation because incorporation and regulation of businesses are squarely creatures of state law. (Id. at 19).
The District Court also rejected the Government’s argument that the CTA could be justified as necessary and proper to carry out Congress’s powers to regulate foreign affairs. (Id. at 22). In support of its argument, the Government proffered the CTA’s congressional findings, including the finding that “malign actors seek to conceal their ownership of [corporate] entities in the United States to facilitate illicit activity, . . . harming the national security interests of the United States and allies of the United States.” (Id. at 22-23, citing Pub. L. 116-283 § 6402(3)). The District Court held that these congressional findings were insufficient to conclude that the CTA is necessary and proper, simultaneously rejecting that the Necessary and Proper Clause extended to all constitutional powers. (Id. at 23).
The CTA is Not Valid Under the Commerce Clause
Second, the Government claimed that the Commerce Clause gave Congress the power to enact the CTA, arguing that the act of corporate formation on its own is sufficient to invoke Congress’ Commerce powers. (Id. at 16). The Court disagreed, holding that the plain text of the CTA, which it noted made no mention of interstate commerce, does not regulate the channels and instrumentalities of commerce, let alone commercial or economic activity. (Id. at 27). The Court stated that Congress could have easily written the CTA to pass constitutional muster by, for example, imposing the CTA’s disclosure requirements on state entities as soon as they engaged in commerce, or from prohibiting the use of interstate commerce to launder money, finance terrorism, or evade taxes. (Id. at 32-33).
Observing that the CTA is “far from essential,” the District Court also held that the Commerce Clause does not extend far enough to sanction the CTA because the future activities of state entities are not sufficient to invoke Congress’s “substantial effects.” (Id. at 34, 43). The Court compared the CTA to FinCEN’s Customer Due Diligence rule (“CDD Rule”), which requires certain “covered financial institutions”—such as banks opening deposit accounts for customers—to “identify and verify beneficial owners of legal entity customers.” (Id. at 43, citing 31 C.F.R. § 1010.230(a)). According to the Court, FinCEN’s CDD Rule and the CTA provide FinCEN with nearly identical information, but the CDD Rule does so in a constitutionally acceptable way. (Id. at 44).[1]
The CTA is Not a Necessary and Proper Exercise of Congress’ Taxation Power
Finally, the Government asserted that the CTA is a necessary and proper exercise of Congress’s authority to tax because one purpose of the BOI database created by FinCEN is to assist in efficient tax administration. (Id. at 16-17). The Government contends “the collection of beneficial ownership information is necessary and proper to ensure taxable income is appropriately reported,” and that Congress recognized this relationship by “draft[ing] the CTA to allow ‘[o]fficers and employees of the Department of the Treasury [to] obtain access to beneficial ownership information for tax administration purposes[.]’” The District Court once again rejected the Government’s argument, holding that to accept the Government’s reading of the Necessary and Proper Clause would permit passage of any law that may involve information useful to tax officials. (Id. at 52). In other words, the exception would quickly swallow the rule.
Implications
It is not yet clear what the implications of this decision will be for entities subject to the reporting provisions under the CTA, and the District Court has not yet ruled whether there will be a nationwide injunction. McGuireWoods is monitoring the fallout from this decision and its effects on reporting companies.
[1] Notably, when the Court discusses the CDD Rule, juxtaposing it to the CTA, it demonstrates a fundamental misunderstanding of the CDD Rule in its comparison. The Court states that financial institutions collect identifying information from customers at account opening and “provide it to FinCEN.” (Id.at 11, 44-45). The Court later states that “the practical similarities between these two regulations make it hard to justify a conclusion that ‘failure to regulate’ corporate entities upon formation would ‘leave a gaping hole’ in Congress’ fight against illicit corporate activity and money laundering…” (Id.at 45). This is an inaccurate description to the CDD Rule and where the information is maintained. The CTA requires reporting of such information to FinCEN to create a centralized database with nationwide information on legal entity beneficial owners. There is no such data base with CDD Rule information. Under the CDD Rule, information on beneficial owners of legal entity customers is maintained within the records of each individual financial institution and is not reported to FinCEN or any other governmental entity, unless requested in the context of an investigation, examination, or other governmental requests.
